For years, pundits have predicted the continued demise of independent retailers. The arrival of shopping malls and power centers drew foot traffic away from the neighborhood Mom-and-Pop stores. Next came the axe wielded by e-commerce giants, notably Amazon. And finally, we saw rents rise to levels beyond affordability for the independent retailers as bank branches, drug stores, fashion houses and other national and international chains competed for space. These factors pressured many of our beloved independent proprietors to shut their doors.
But rents continued to rise rapidly as the economy recovered from the 2008 recession – up by 60% in some established corridors over the last decade - and sales, largely due to growth in e-commerce, have not kept pace. Even deep-pocketed chains have been pressured to close: Starbucks has started to shut some of its New York locations, citing rent increases of as much as 100%. With vacancy rates as high as 20% in some affluent neighborhoods; some of the most storied retail corridors are deeply troubled. In New York City, a stroll through the West Village, along Fifth, Madison and Third Avenues, and uptown to the Upper West Side, reveals an alarming number of vacancies.
One observer dubbed the trend “high rent blight.” And the pain may not be over. We are likely to see more bank branches close over time as consumers shift more towards online banking. Drug stores and grocery stores are likely to move towards smaller footprints with the continued rise of online shopping.
However, urban retail is not dead - and over time, we will return to a state of equilibrium, with lower rents and higher occupancy levels. But how will we get there? When will landlords finally lower rents? Where will the demand come from to fill all of the empty storefronts?
Decreasing rents and landlord capitulation
On the foundation of a steep rise in rents, landlords purchased, financed and/or refinanced properties with unrealistic rent and tenant quality expectations. Building owners are natural optimists, believing that the perfect national credit tenant is just around the corner. When space is vacated, they will often wait, rather than lease to a local operator at a lower rent. As a result, store fronts can stay empty for months, or even years.
Since many owners underwrote their properties using unrealistic cash flow projections, their ability to sign leases at rents below the original pro forma means admitting to a lower value of the property than anticipated. This can be hard to accept. Signing leases at current market rents can also be constrained by a property’s mortgage terms, as signing tenants at lower-than-anticipated rents can result in an inability to service or refinance debt - or may even result in a breach of loan covenants.
Despite the resistance from landlords, rents have begun to decrease and are poised to decrease even further over time. Some owners will grow impatient with persistent vacancies and lower rents to attract tenants. Other leveraged owners will ultimately face a mortgage maturity and will be forced to sell at a loss or turn the keys over to their lender. Once these properties change hands, new owners (or lenders) will have a lower cost basis and more flexibility to sign leases at lower rates.
Retail 2.0 and the return of the independent
Changing demographics and consumer preferences are signaling increasing desirability of smaller, curated and customer-service-oriented retail outlets. As rents return to more-affordable levels, smaller, nimbler and more-creative operators are likely to prosper.
Today, many millennials, retiring baby boomers and senior citizens want a more urbanized lifestyle in neighborhoods that offer mass transit and a range of services. A recent study by the Urban Land Institute indicates that 48% of all millennials - which now represents the largest cohort in history - live in walkable “city neighborhoods.”
These factors have very positive implications for the rebirth of urban neighborhood retail. Lower operating costs will attract smaller stores and restaurants - as independent retailers target these urban locations, which boast pedestrian-oriented, street-front retail environments. At the same time, successful retailers will adapt approaches to attract the shopping public - creating unique shopping experiences that cannot be found online.
Retail strength is increasingly found in services-based, rather than goods-based formats. In addition to “Amazon-proof” entertainment and recreation venues, stores offering unique in-person experiences are positioned to compete effectively. Today’s consumers view certain types of shopping as a leisure activity, relegating basic purchases to online transactions.
As a result, environments in which shopping is treated as an experience in its own right, will come to dominate the bricks-and-mortar landscape. Staff in independent stores are highly knowledgeable, ready with product information on suitability, materials and the production process. Increasingly, shoppers are once again looking for life beyond their computer screens - and this can only benefit the independent retailer, who is more inclined to offer a high level of interaction with the customer.
A corollary to experiential shopping is personalization. Consumers like to shop where they are recognized and their preferences are understood and remembered. This also plays to the strengths of local, independent operators, many of which will turn to technology to enhance the customer experience: They send personalized offers directly to their clients’ mobile devices and can easily make mobile payment options available.
Some evidence suggests that this trend is already taking hold. For instance, take the independent bookseller. The Wall Street Journal reported recently that their ranks had increased by almost 18% between 2010 and 2015, even as Borders closed its doors, Barnes and Noble faltered and Amazon threatened to devour the industry. This growth was thanks in large part to the tools successful book sellers have always used: Personalized, attentive, knowledgeable service and carefully curated inventories - both of which give shoppers a reason to return.
In addition, the number of neighborhood supermarkets grew by 10% between 2013 and 2015 in New York City, according to data from Crain’s, as small independent operators, often members of local buying cooperatives, narrowed their inventories to feature fresh prepared foods and other products demanded by locals that don’t easily lend themselves to online shopping.
As urban commercial vacancies linger and rent capitulation takes shape, we will see some creative entrepreneurs filling current vacancies with new and innovative retail concepts. It should, in fact, be a very exciting time to be a consumer.
Originally published in ‘Business Insider’